How debt accumulated during the financial crisis still poses a threat to the banking system.

By Spencer Venable
May 2016

Preface
The removal of the Glass-Steagall Act in 1999 marked the end of a period of financial
stability that began when it was put in place as part of the emergency Banking Act reforms of
1933. The Glass-Steagall Act separated deposit taking banks from investment firms and

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effectively helped to protect the savings of millions of people for more than 60 years. When the
act was fully removed after years of political lobbying from banks, financial markets jumped in
value with stocks hitting their highest valuations ever in history in the year 2000 (even more
extreme than the peak of 1929), only to crash and lose more than 50% of their value in both
2000-02 and again in 2008-09. The second crash in 2008 set off the worst financial recession
since the Great Depression. The 2008 financial crisis led governments and central banks around
the world to enact a series of emergency policies that would increase the debt in the financial
system in the hopes of reflating economic growth. The result has been the weakest economic
recovery on record. Growth did not rebound as hoped for; however, global debt levels expanded
by nearly $60 trillion to an all time high today. The risks of another financial crisis and major
global recession have increased given poor global growth and a heavy debt burden that remains.

Table of contents
Preface
Table of Contents.
Background.4
Significance13

Spencer Venable

Experts...16
Role of Control..19
Logic of Evil..........................................................................................................................21
Case Studies:
1. China
..24
2. Australia
.29
3. England
..35

International Organizations....38
Canadian Connection.42
Solutions47

Background
In 1929, America experienced the largest financial crash and banking crisis in its history,
economies all around the world suffered major setbacks as a result. In America alone many
banks and other businesses went bankrupt, unemployment rates jumped to 25% and the average

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household income dropped by 40%.1 This economic collapse became known as The Great
Depression and lasted from 1929 to 1939.

In response, the US government passed The Banking Act of 1933. This act helped to
protect the savings of millions and create financial stability for decades afterwards. It achieved
this in two key ways: first it established the taxpayer funded Federal Deposit Insurance
Corporation (FDIC) which - in the event of a bank insolvency - insures deposits by up to
$250,000 per customer, secondly by controlling the level of leverage and risk in the financial
system by separating securities sales firms from the commercial banks (The Glass-Steagall Act)
that were backed by the FDIC insurance. This division meant that FDIC backed banks could
only use customer deposits to make conventional mortgages and loans, but not for financial
speculation and trading activities that had a high risk of capital loss. Those firms wanting to
engage in speculative financial activities were required to do so risking their own capital at risk
of only personal bankruptcy.

These provisions helped to stabilize the financial system into the early 1960s until banks
began lobbying politicians to loosen the Glass Steagall divisions and allow them to expand once
more into investment underwriting and sales. Finally, in 1999 President Bill Clinton signed the
Gramm-Leach-Bliley Act which repealed the separation between banks and securities sales firms
and effectively allowed banks to use FDIC insured customer deposits for high risk activities.2

1 "Unemployment Statistics during the Great Depression." Unemployment Statistics during the
Great Depression. N.p., n.d. Web. 13 May 2016.
2 "History of Glass-Steagall Act." An Equal Say And An Equal Chance For All. N.p., n.d. Web. 06
May 2016.

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In the 16 years since the Glass Steagall Act was repealed, the US has already experienced
two massive financial market declines, one in 2000-03 and another in 2008-09. Both events
triggered costly recessions. The collapse in 2008 has been called The Great Recession and
The Great Financial Crisis (GFC) being the largest economic decline in world history next to
The Great Depression.

Today, eight years after excessive debt levels and financial speculation triggered the
Great Financial Crisis of 2008, debt in the global banking system has increased by tens of
trillions of dollars, and the largest banks backed by FDIC insured deposits, represent an even
more concentrated risk to the economy. The five biggest financial institutions in the US have
been called Too big to fail, by financial regulators because allowing one of them to go
bankrupt would cause debilitating losses to customer deposits and the taxpayers who are backing
them via FDIC coverage. As we enter 2016, the risk of the next great financial crisis is arguably
larger than ever.

In the early 1920s, wealthy families commonly hired independent financial advisors to
work directly for them in helping to manage their money and assets. These advisors were paid
by their clients alone and had a fiduciary duty to always place their clients best interests ahead
of everything else. Fiduciary advisors (like lawyers and doctors) are by law prohibited from
taking advantage of their clientsthey must not make any secret profits or operate with conflicts
of interest that maximize their own financial gain at the expense of their clients.

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Securities sales firms on the other hand were in the business of creating and selling
investment products. They saw great opportunity in convincing financial advisors to recommend
these products to their clients.

In the late 1920s securities sales firms began merging with banks and buying up private
asset management and advisory practices with the goal of gaining a distribution channel for their
products. The trouble was that their products were high on fees for the investment banks and
low on protection for the clients. Those selling the products were brokers that collected rich
hidden commissions and incentives for getting their clients to buy them. Independent fiduciary
advisors became increasingly replaced or turned into sales people. Meanwhile the investment
conglomerates made little attempt to inform clients of the mandate change from advising to
sales.3

As more financial products like stocks and bonds were issued and sold, the more prices
increased, so did debt. Investment firms discovered that their customers could buy a lot more
products if they were given investment or margin loans to purchase securities. As the value of
the assets purchased increased, the banks lent more money to borrowers so that they could buy
more and more securities. With more investor demand, banks were able to issue more bonds and
use the money to make consumer loans to their customers. Lending standards dropped and credit
quality (the likelihood of being paid back) declined while capital risks for investors rose.
Finally, the debt bubble burst and in 1929 stock and bond prices collapsed, with the Dow Jones
Industrial Average (the 30 largest US company shares) dropping 80% over the next 3 years.
3 Moulton, Harold Glenn. The Financial Organization of Society. Chicago, IL: U of Chicago, 1921.
Print.

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With the amount of damage that the Crash of 1929 inflicted on the world economy and
the lives of families, in 1932 the US Senate Committee on Banking and Currency began a twoyear investigation as to the cause and who was responsible. In June of 1934 it released its
conclusions in a 394-page report that states (my underlining of key points):
Many of the evils that were disclosed at the hearings before the United States
Senate subcommittee were inherent in the interrelationship of commercial banking and
investment banking. A great many of these evils were, however, attributable to the utter
disregard by officers and directors of commercial banks and investment affiliates of the
basic obligations and standards rising out of the fiduciary relationship extending not only
to stockholders and depositors, but to persons seeking financial accommodation or
advice. The hearings disclosed, on the part of many bankers, a woeful lack of regard for
the public interest and a proper conception of fiduciary responsibility. Personages upon
whom the public relied for the guardianship of funds did not regard their position as
impregnated with trust, but rather as a means for personal gain. These custodians of
funds gambled and speculated for their own account in the stock of the banking
institutions they which they dominated; participated in speculative transactions in the
capital stock of their banking institutions that directly conflicted with the interest of these
institutions which they were paid to serve;

borrowed money from the banking institutions either without or with inadequate
collateral; procured the banks loans for other individuals to effectuate the purposes of
these officers and directors; informed private companies to cover up operations
conducted for their own pecuniary gain; availed themselves as directors of private
corporations, of inside information , to aid them in transactions in the securities of these

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corporations; caused to be paid by the banking institutions to themselves excessive
compensation; had voted to themselves participations in management funds and
substantial pensions, and resorted to devious means to avoid the payment of their just
Government taxes.

In the end the government implemented what it identified as three critical areas of reform:
The Securities Act of 1933 and the Securities Exchange Act of 1934 have vested the
Securities and Exchange Commission [SEC] jurisdiction of the source of and traffic in
securities.

The vigilant administration of these acts should materials abate, if not

eradicate, abuses that have caused much economic distress. The establishment of an
honest and true securities market is dependent upon the effective enforcement of the
legislative mandates in these acts.

In the field of banking, three major principles have been dealt with in recent legislation,
namely [The Banking Act of 1933], the separation of monetary policy from banking, the
creation of deposit insurance [FDIC] and the separation of investment banking and the
securities business from commercial banking [Glass Steagall].

These legislative changes helped to strengthen and protect the banking system for three
decades. However, in the 1960s the banks began lobbying the rules instated by the Glass
Steagall. First they lobbied Congress to allow them to enter sales of municipal bonds and they
slowly succeeded. In 1986 the Federal Reserve Board who has oversight control on banks and
monetary policy removed section 20 of the Glass Steagall Act. This allowed the banks to expand
into the securities business to maximum of 5% of their profits. Then this spread and in January
1989, the Federal Reserve allowed the requests of JP Morgan, Chase Manhattan, Bankers Trust

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and Citicorp for unlimited dealing in debt and equity securitization. Then in 1998 Travelers
Investment Bank was allowed to merge with Citigroup and Glass Steagall was effectively ended
before being officially removed in 1999 by President Clinton.4

Nine years after the official removal of the Glass Steagall Act, the Great Financial Crisis
sparked a worldwide recession. This collapse began in the US mortgage and housing sector but
thanks to the international reach of the largest financial firms and globalization the collapse in
American housing stunted the growth of economies worldwide: China, Australia and England are
all key examples that will be covered in detail later.

In September 2010, the US Senates Financial Crisis Inquiry Commission held hearings
into cause of the 2008 market crash and who was responsible. In the end, the government
commission referred evidence of numerous violations of federal securities laws by investment
banks to the US Department of Justice (DOJ). In response, the DOJ spent the next 6 years
negotiating just over $40 billion in faceless fines. A total of 18 large financial institutions, all
done without naming or holding one single executive or individual civilly or criminally liable for
admitted offences. No bank executives went to jail in America.5

In truth, the $40 billion in fines were a tiny fraction of the hundreds of billions in profits
the crimes continue to generate for the biggest banks. The fines were an expense of doing
business paid for by taxpayers and shareholders like pension beneficiaries and mutual fund
4 "A Brief History of the Glass-Steagall Act." An Equal Say And An Equal Chance For All. N.p., n.d.
Web. 09 May 2016.
5 Eisinger, Jesse. "Why Only One Top Banker Went to Jail for the Financial Crisis." The New York
Times. The New York Times, 03 May 2014. Web. 06 May 2016.

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holders. Meanwhile, the actors and executives who profited most from the illicit acts were
allowed to retain all their pay and freedom to continue a lucrative career.

The 2010 Financial Crisis Inquiry identified many of the same factors and incentives
leading up to the 2008 market crash as had been noted leading up to 1929. Banks being allowed
to work hand in hand with investment banks were enabled to make risky loans to people with
poor income and credit history by selling the loans off as securities to other investors. Since the
banks were cashing their money out and not holding on to collect the loan payments, they began
to care little about whether the people borrowing were a good credit risk. The investment sales
arms of the banks were making millions in commissions packaging the loans and then
recommending them as solid investments to pensions and mutual funds around the world. As
more people bought, more and more risky loans were made and the more cash flowed back into
the banks to make even more loans. As more people got loans, more were able to buy real estate
and the prices soared. This caused a sudden rise in housing values and with down payments on
loans reaching as low as zero people began leveraging money to purchase more housing creating
a surge in housing sales.

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This chart shows the volume of sales that rose very quickly leading up to the beginning of the
collapse in 2007. And when the purchasing of homes stopped so suddenly those who leveraged
money to purchase were left with homes that no one would purchases and large debts to the
bank. This also meant that banks were not recollecting a lot of the money they had given out
causing many of the large banks to become insolvent. For fear of recreating the devastating
collapse of 1929 the FED (Federal Reserve) bailed out the banks allowing them to continue their
investment banking operations.6

A development that did come out of the Great Recession however was the creation of the DoddFrank Wall Street Reform and Consumer Protection Act (2010). The stated purpose of the act
was to prevent banks from becoming too big to fail, putting an end to government bailouts with
taxpayers dollars, and creating organizations to watch over the banking sector, and enforce the

6 "What Is Quantitative Easing?" The Economist. The Economist Newspaper, 09 Mar. 2015. Web. 09
May 2016.

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rules. However, the act failed to re-separate the FDIC backed commercial banks from their
investment sales divisions and there is much doubt as to whether or not the Dodd - Frank Act
will truly help prevent the next crash or at least stop the government from bailing the banks out
with taxpayers dollars. Most of the participants, practices and incentives to create excessive debt
and leverage and risk remain embedded in the present financial system.

Significance
The Financial system is used by nearly everyone in the world. The real economy, which is
made up of businesses and families, depend upon a stable and reliable financial system to
function. This means that widespread corruption and illegal actors can be catastrophic for the
lives of many. A clear division between savings deposits and financial speculation must be
reinstated. In the year 1933 at the end of the Great Depression a total of 9000 banks7 went
7 "A History of Bank Failures in the United States." DaveManuel.com. N.p., n.d. Web. 09 May 2016.

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bankrupt taking with them the savings of millions. Between 1945 and 1960 after the Glass
Steagall Act was put in place and a total of just 42 banks went under. This is clear evidence that
the Glass Steagall Act worked to remove risk from the system giving protection to the consumer.

A trend being seen in countries that have economies based around the exporting of raw materials
(Canada, Australia) is incredibly overvalued markets. This is because when the Great Recession
of 2008 occurred these nations were supported by the extend and pretend tactic that was
utilized by China (Australia's largest trading partner) and U.S (Canadas biggest trading partner).8
The phrase extend and pretend used by market analysts means that when the collapse hit China
and America they took on took on more debt to push capital into their economies in the hopes
that extra cash would make consumers at home borrow and that their spending and government
spending could jumpstart their economies long enough for global demand to bounce back. This
plan did not work for long however as growth slowed again in 2011 and borrowing continued.

The debt financing boosted commodity demand for a time and raised prices, but as prices
increased, producers thought this was a new demand boom and began increasing production for
more supply than the world was using. This lead to the stockpiling of excessive inventories that
were not being consumed. It also means that it will now take longer for the world to work down
the oversupply that has built. This leaves exporters like Canada and Australia at risk of an
extended downturn.

8 "Canada." OEC. N.p., n.d. Web. 09 May 2016.

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At the same time, households and companies in these countries misunderstood the rebound in
prices during 2008-11 as a resumption of the economic boom that had been in place from 200308. They were encouraged to continue spending beyond their income and took on record
amounts of debt to buy things and spend on discretionary items. This has left them weaker
financially and less able to ride out the next recession which lies somewhere ahead.
Since the 2008 recession, the world has increased the level of total debt by an estimated $57
trillion dollars to a total of $200 trillion of debt outstanding globally. 9

Since $200 trillion is about 4 times the $50 trillion dollars in global circulation, it raises a
legitimate question as to how this amount of debt can ever be repaid. It is quite possible that
some of it cannot be, and a portion will have to be written off as a bad asset in order for the
world to restart a sustainable period of economic growth.

9 "Debt and (not Much) Deleveraging." McKinsey & Company. N.p., n.d. Web. 03 May 2016.

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Experts

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William K. Black is a world renowned financial analyst who played a large role in prosecuting
financial crimes and corruption during the Savings and Loan crisis of the late 1980s. Black
worked as litigation director for the Federal Home Loan Bank Board (FHLBB) from 1984 to
1986, deputy director of the Federal Savings and Loan Insurance Corporation (FSLIC) in 1987,
and Senior VP and the General Counsel of the Federal Home Loan Bank of San Francisco from
1987 to 1989, which regulated some of the largest thrift banks in the U.S. Black has much first
hand knowledge on the fraud and other crimes that are common in banking history and offers
many solutions for the issues at hand.10 Unlike some professionals in the field Black simplifies
concepts, taking the complex words used in finance and putting them into simple english that the
masses can understand. This makes him a very valuable man as he educates people on the overly
complex financial system that is so important in most people's lives. During a TED talk Black
did in 2013 he stated;

So our task is to educate ourselves so that we can understand why we have these
recurrent, intensifying financial crises, and how we can prevent them in the future. And
the answer to that is that we have to stop epidemics of control fraud. Control fraud is
what happens when the people who control, typically a CEO, a seemingly legitimate
entity, use it as a weapon to defraud. And these are the weapons of mass destruction in
the financial world. --William K. Black. 2013

When the 2008 banking crisis hit, Iceland hired Black to train their own prosecutors on how to
catch and convict the offenders working in their banking system. Following his advice the
country successfully convicted many of the criminals involved. Unfortunately other countries
10 "William K. Black." UMKC School of Law. N.p., n.d. Web. 13 May 2016.

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including the USA did not take Blacks advice.

Even though he offered to help the US

Department of Justice in their investigations, they did not use him and none of the directing
people behind the widespread loan fraud in the US were punished personally or imprisoned for
their crimes.11

Dr Robert Shiller is among the top 100 most influential economists in the world.12
Currently serving as a Sterling Professor of Economics at Yale University, he has had a full and
very influential career in finance. In 1967 Shiller received his B.A. degree from the University of
Michigan. He then went onto receive his S.M. degree from the Massachusetts Institute of
Technology, and a Ph.D from MIT in 1972, with his thesis entitled Rational expectations and the
structure of interest rates.13

He also wrote a best selling book called Irrational Exuberance about the stock market
that was published in March of 2000, just as the US stock market was forming a peak bubble that
drove prices to the highest valuations in history. Shiller is also an author with 12 publications and
an active website where he posts articles he has written that analyse different aspects of the
economy and investor behaviour.

In 2013 he was awarded the Nobel Memorial Prize in Economics for his empirical
analysis of asset prices. Another significant contribution by Shiller was the creation of the Case11 "William K. Black." Wikipedia. Wikimedia Foundation, n.d. Web. 09 May 2016.
12 "Top 10% Authors, as of March 2016." Economist Rankings at IDEAS. N.p., n.d. Web. 30 Apr.
2016.
13 "Robert J. Shiller." Wikipedia. Wikimedia Foundation, n.d. Web. 13 May 2016.

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Shiller Home price index. This index is an amalgamation of the national home price of nine major
census divisions. It is calculated quarterly and published on the last Tuesday of February, May,
August and November. The 10-city composite index, which covers Boston, Chicago, Denver, Las
Vegas, Los Angeles, Miami, New York, San Diego, San Francisco and Washington, DC. The 20-city
composite index, which includes all of the above cities plus Atlanta, Charlotte, Cleveland, Dallas,
Detroit, Minneapolis, Phoenix, Portland (Oregon), Seattle and Tampa. 14 It is a broadly used index as
it accurately represents house pricing using many different cities in America as the source.

The Shiller Index allows economists to monitor trends in home prices for signs of risks and
benefits they may pose to the economy. Others use the index to hedge or offset the risk that they
have in holding a concentrated amount of real estate in a particular area.

Role of Control
The S.E.C (Securities & Exchange Commission) was put in place June 6, 193415 with the
purpose of regulating and creating laws based around the financial system. The current head of
this organization is Mary Jo White. Starting as a litigation lawyer in 1993, White made many
14 "Understanding The Case-Shiller Housing Index | Investopedia." Investopedia. N.p., 18 Jan.
2010. Web. 01 May 2016.
15"About the SEC." SEC.gov. N.p., n.d. Web. 13 May 2016.

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connections in the finance industry while defending Wall Street banks. Her husband continues to
work as a lawyer representing large banks on Wall Street.

In 2013 she was nominated as the chair of the S.E.C by President Barack Obama. As
chairman of the S.E.C she directs which charges against banks are prosecuted and referred to
trial and also the terms of any settlement negotiations. One of her first actions as Chairman was
making the SEC demand more admissions of misconduct as part of an enforcement settlement.
For the first 5 years after the financial crisis, banks were allowed to negotiate fines to regulators
for illegal activities without having to admit nor deny any wrongdoing. This left actors free to
continue in the finance sector with personal immunity. When White arrived at the SEC she took
a public stand saying that banks were treating settlements as a cost of doing business, where the
profits they retained justified the continuation of illegal activities. White said she intended to be
harder on them. Many people have complained that her actions since, have not lived up to these
words. On June 2, 2015 Sen. Elizabeth Warren wrote a letter to White indicating that her
"leadership of the Commission has been extremely disappointing".16

The very control that banks and NGOs such as the SEC have over the economy is a large
issue that few are educated on. It is necessary that people understand the roles of these
organizations and that they look deeper into the work history of the key players in the
organization. The amount of direct connections chairmen of these organizations have had with
banking is rather shocking when looked into. This creates - for the most part - a system without
much regulation as the NGOs put in place to regulate are run by people who have been
16 Senate, Elizabeth Warren. "United States Senate." (2015): n. pag. Warren Senate. 2 June 2015.
Web.

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executives in the finance industry. Although it is a common trend in most industries for people
who formerly worked in the trade to later regulate it, in the case of finance no-one is fully held
accountable for the mistakes. When the banks sell mortgage backed securities to their clients
and allow for the leveraging of debt to purchase more MBS (mortgage backed securities) the
S.E.C (building inspector) allows it. When the markets reach a point of inflation where they
collapse (the collapse of the building) no one is held accountable, not by the public, the
organization's who regulate the system, not even by the criminal investigators and prosecutors
like the FBI and the Department of Justice.

A great example of this was in 2008 when the Great Recession occurred. Even though it
was an acknowledged fact that the 2008 meltdown occurred largely due to the selling of
subprime loans on a large scale and making fraudulent representations to investors that the assets
were high quality, only one individual, high ranking bank employee went to jail. None of the
executives who oversaw and profited the most off of these operations were held accountable.17

Logic of Evil
As much as the drive for personal gains is part of human nature, it is also our nature to
feel guilty if our actions are to have a very negative effect on someone elses life. However,
cognitive dissonance (logic of evil) is what allows people to do wrong to others being fully
aware of it and not feel guilty. A great example of this is when Ferdinand Pecora (lawyer famous
for his interrogation of Wall St. bankers in front of the Senate Banking Hearings in 193318), got
Charles. E. Mitchell the head of City Bank, to reveal many details of City Banks unscrupulous
17 Eisinger, Jesse. "Why Only One Top Banker Went to Jail for the Financial Crisis." The New York
Times. The New York Times, 03 May 2014. Web. 13 May 2016.
18 PBS. PBS, n.d. Web. 13 May 2016.

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selling of harmful financial investments to their customers Mitchell and others executives
seemed to do so with no shame or remorse that they had profited so richly at the expense of
others. This is the theory of cognitive dissonance applied to the finance industry. As the
industry moved towards larger gains for the company and higher risk for the clients, the morals
of the bankers involved seemed to morph to believe that what they were doing was legitimate
and worthy of respect.

This same effect is the reason why the actions of financial companies are so hard to
control, and why the organizations made to do so run into many difficulties. Early on in the
history of investment banking, banks and politicians developed close work relationships in order
for the so called money men could help with funding and influence to get the politicians
elected. In return the politicians were then more open to helping the bankers in their businesses.
This spread to regulators as well, who were appointed by politicians to oversee the banks.

Today the finance sector is one of the largest contributors to campaign finance for
Democrats and Republicans. In addition, at the end of their term, many regulators are asked to
come work with large finance firms who are happy to pay them more than they were earning, in
order to help the banks influence the regulatory system to their benefit. This is known as the
revolving door between government and finance.

At the same time politicians and finance workers have been known to share insider
information that allows them to profit personally, before information is available to the general
public. This is illegal for the general population, but lawmakers had left a loophole allowing
themselves and bank lobbyists to get away with it anyway.

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A recent example was when Nancy Pelosi speaker of the U.S House of Representatives
purchased shares of Visa just as a major legislation that was moving through the House of
Commons that would cause the Visa stock value to sky rocket. She and her husband reaped
huge profits. When questioned on this by reporters Pelosi claimed that It was in no way a
conflict of interest and that she has many investments and is not aware of why this is of
importance. However, this caused a large commotion in the media who pushed the government
to make new rules to close the insider trading loop hole, this legislation is called the Stock Act
passed in 2012. The Stock Act made it so the records of politicians purchasing and selling stocks
was available as part of the public record and could be monitored. However, these files are kept
in the basement of a government building. Meaning that if the public wished to view this
information they first need access to the basement and then find the specific file in the 35,000
files kept19.

19 Gongloff, Mark. "Stock Act Change Just Quietly Made It Easier For Top Federal Employees To
Inside Trade." The Huffington Post. TheHuffingtonPost.com, n.d. Web. 13 May 2016.

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Case Studies
China
In the years leading up to the housing crash of 2008, U.S consumers increasingly
substituted stagnant household incomes with greater amounts of cheap debt. The banking
industrys use of new credit products (specifically mortgage-backed securities) helped reduce
risk to creditors from defaulting borrowers. The lowering of risk by pooling mortgages with
differing credit ratings made it possible to add another tranche level of credit quality into the
mix called sub-prime. The ability to include lower credit quality debt in the creation of MBSs
(mortgage-backed securities) meant that an entirely new segment of U.S consumers were now
able to access larger loan amounts, despite low incomes. This new group of consumers helped
push purchases of goods to new heights.

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20

The chart above illustrates the rapid increase in U.S consumer household debt in relation
to household incomes, the rise is especially noticeable during the period 1998 to 2009.

The chart above illustrates the dramatic rise in Chinas exports to the U.S to show the reciprocal
relationship to U.S household debt levels.

20 "Consumers and the Economy, Part II: Household Debt and the Weak U.S. Recovery." Federal
Reserve Bank of San Francisco. N.p., n.d. Web. 13 May 2016.

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With China being the worlds largest exporter of inexpensive goods to the U.S, it saw a
large boom in their economy. More manufacturers opened up meaning many new jobs were also
made.
The increased amounts of American money in the Chinese economy also accelerated the
growth of the middle class, prior the country only had two social classes. The upper class which
made up 11% of Chinas population; this group consisted of politicians, management of state-run
businesses owners with key political ties. The average income of this group was $44,000 USD a
year. The second social class was much poorer than the first. This group was made up of the
middle and lower class. The reason for this is the difference between the two is simply not
enough to justify labeling them separately. The so called middle class made $9,000 - 16,000
USD a year. While the lower class made $9,000 or less USD a year. This shows the income
difference between upper and lower class is $28,000 USD whilst the difference between mid and
lower is only $5000, really not enough to differentiate the two classes. The lower class was
employed mostly as factory line workers, farmers, and tradesmen.21

Chinas class system remained segregated by a large gap between the two groups until
U.S demand triggered a wave of new factories and businesses to be made. Tradesmen were in
high demand as they were needed to build the infrastructure required to supply the boom.
Another factor that helped towards the growth of the middle class was that once projects were
completed, it opened up positions for managers and other higher paying staff. This trend
continued until 2008 when the U.S financial markets crashed, sending shock waves across the

21 "Mapping China's Middle Class." McKinsey & Company. N.p., n.d. Web. 23 Apr. 2016.

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globe. Demand for exports from China fell dramatically and this led to job losses. The
unemployment rate jumped in China as shown here.

In response to the 2008 financial crisis and related collapse in export demand, China
initiated an enormous stimulus package valued at roughly 4 trillion Yuan. The government
funded initiatives were quickly put in place to maintain economic output and political stability.
Infrastructure projects took the form of transportation systems such as new high-speed trains,
airports, highways, dams and sewage plants. Large scale housing complexes with commercial
and retail spaces were being built far and wide throughout the country. In some extreme cases

entire cities were built.

The expectation (hope) was that the new buildings would become home to farmers and
rural workers migrating to the cities for higher paying jobs, it was also thought that the work
force building the projects, would one day live in them. These expectations were never realized
because the average Chinese worker in 2006 had an income of 4861.61 Chinese Yuan ($750
USD) per month. For example, when the city of Ordos was built apartments averaged $1,100

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USD per square foot; far from the reach of anyone in the working class.22 This left Ordos and
other massive cities like it to be abandoned, getting them the title of Ghost Towns. However,
the development of more of these cities is still under way today. This is mainly because the
building projects main intent never were (although claimed to be) to house the new upper middle
class. This is clear when we consider the price of housing was never in reach for the middle class
at anytime before during or after the 2008 crash. Even for the upper class with a annual salary of
$44,000 USD23 they would be required to save all their income for 25 years to be able to afford a
1000 square foot apartment at 1,100 USD per square foot in Ordos24. What the government
wished to achieve was the creation of jobs to help stimulate their economy, and at this it was
successful. The unemployment rate which was still very high from the effects of the Great
Recession nearly returned to the pre-crisis at the beginning of 2008. The middle class now has
reconvened with the lower class as they have the same housing and can afford mostly the same
things. The only separation between the two is the middle has a slightly bigger paycheck.
Despite attempts to support the Chinese economy with more unneeded infrastructure, Chinese
leaders now say that the previous growth rates were unsustainable, setting new lower target of
6.5% to 7%. Other than the construction of infrastructure, the Chinese economy has been driven
mainly by exports, which are now falling (chart above). As Europe and North America reduce
consumption, China now has to confront the reduction of demand for its exports and shift to
growing consumption at home.

22 Lubin, Gus. "TIMBER! Home Prices Are Crashing In China's Most Famous Ghost City." Business
Insider. Business Insider, Inc, 06 Dec. 2011. Web. 23 Apr. 2016.
23 "Mapping China's Middle Class." McKinsey & Company. N.p., n.d. Web. 12 May 2016.
24 Lubin, Gus. "TIMBER! Home Prices Are Crashing In China's Most Famous Ghost City." Business
Insider. Business Insider, Inc, 06 Dec. 2011. Web. 23 Apr. 2016.

Spencer Venable

Australia
Just as Canada is the resource warehouse for America, the largest economy in the world.
Australia is the resource warehouse for China, the second largest economy in the world. As the
credit/housing boom took off in America during the year 2003, Chinese manufacturing soared
and Australias GDP growth went along for the ride as shown in this chart since 2001.

The mining and energy sector created many well paying jobs which allowed Australian
consumers begin borrowing and spending accordingly. This next chart of Australian household
debt to GDP shows a 80% increase in consumer debt levels between 1990 and 2011.

Spencer Venable

*Note the small looking bump that occurred around the Great Depression in the 1920s - to 30s
in reference to its current position in the 21st century - markets have inflated to four times their
position in the 20s and 30s - .

As Americans experience mortgage backed securities created by the international

financial conglomerates subprime mortgages were issued on Australians as well. This debt

Spencer Venable

shown in the chart above was encouraged by lack of government taxation on second properties
for Australians. This created above average inflation in real estate prices, with gains of more than
10% a year in hot areas like Sydney, Melbourne and Brisbane as shown below.

Consumer spending as a percentage GDP in Australia is almost identical to Canada at

56%.25 As their home prices rapidly increased, Australians felt more wealthy and confident and
with increased confidence come rising levels of debt. For a while strong income gains, driven by
the commodities boom helped them to afford their higher debt payments and increase spending.
This of course did not last. When international demand dried up in the American mortgage crisis
in 2007-08, Chinese exports plunged and demand for Australias products did as well. This lead
to a drop in employment and the Australia's housing market began to decline for the first time in
several years.

For a short period of time after the popping of the bubble large losses were seen.
However, as the Chinese began its massive stimulus spending on infrastructure in 2008, demand
for Australias exports bounced with it. This meant that Australia (Chinas main source of raw
materials) got a large boost in demand for their natural resources. Western countries like
America, Canada, Europe and Australia interpreted the rebound in Chinese orders for their
exports as a sign that the 1.3 billion people in China were becoming western style consumers.26
They responded to this optimistic assessment by increasing their spending and taking on even
more debt.
25 "Household Final Consumption Expenditure, Etc. (% of GDP)." Data. N.p., n.d. Web. 23 Apr.
2016.
26 Mansbach, Richard W., and Kirsten L. Taylor. "The Global South."Introduction to Global Politics.
London: Routledge, 2008. 167. Print.

Spencer Venable

China purchased 36% of all Australian exports, mostly iron ore. Iron ore makes up 57%
of all exports from Australia to China.27 In the year 2009 right after the recession, China alone
purchased $32 billion dollars worth of Australian exports which played a key role in keeping
their economy afloat.

As a result of Chinas stimulus spending, the Australias housing market began

recovering quickly. A couple of other factors worked to boost realty prices further. A large one is
the lack of a government tax on second properties was a big factor. The lack of this tax was a
huge incentive for people to purchase multiple properties. As a comparison Canada a 25% (50%
on certain properties) government earnings tax on second properties. Therefore if one were to
sell a property which is not a primary residence they are to pay tax on any profits. In Australia
however, there are no taxes on second properties, making it an ideal place for people to borrow
money to purchase multiple homes with the hopes of selling them once their value goes up. In
addition, in Australia if an investment property creates a loss--as in the rents received are less
than the costs of maintaining the property--the owner is allowed to write off the loss against their
employment income. This means they can lower the tax they owe on their overall income. This
lack of taxation boosted the Australian housing markets massively and put their household debt
to GDP ratio to new highs.

27 "Products That Australia Exports to China (2009)." The Observatory of Economic Complexity.
N.p., n.d. Web. 30 Apr. 2016.

Spencer Venable

The other major buyer for Australian real estate was wealthy Chinese investors who were taking
money out of China and looking for diversified places to park it around the world. Australia was
a natural selection. Australian markets continued to increase as shown in this next chart.
This chart shows the housing index in Australia from the 1880-2014 (in red), and shows the
temporary sell off in 2008 followed by the dramatic rebound in Australian realty prices after the
US topped out in 2007 (in blue).

As the Chinese stimulus spending ended in 2011, commodity prices began to fall once
more as shown in this chart of the CRB (Commodities Research Bureau) commodities index
1995 to 2015.

Spencer Venable

Australias economy began to weaken with commodity demand once more and job losses
began to spread. Because Australian households, business and government were more indebted
than ever before, loss of income has been very difficult to manage. For a while, spending had
continued thanks to a lowering of lending standards similar to what happened in America in
2005-07. The problem is that world growth is not bouncing back to levels seen in the mid2000s. As the population in the west is growing older they are spending less money. In addition
they are having to build up their savings and pay down still massive debt levels. This will take
several more years, and is likely to hold back consumption and demand for Americas exports.
At the same time, thanks to the government stimulus spending of China and other countries
during 2008-11, the world has record levels of commodity inventory already on hand in storage.
It will take several years to consume the products already on hand and this means the weak
demand for new products from Australia is likely to continue suppressing the countries income
just as the people struggle to pay back massive debts at home. This means the home prices at
record highs are likely to decline and cause rising loan defaults, bankruptcy and losses in the
finance and service sectors. This puts Australia at increased risk of a prolonged recession.

Spencer Venable

England
In 2003 the United States brought in legislation called the Sarbane Oxley Bill which
required corporate executives and accountants to be held personally responsible for the financial
information reported in corporate financial statements. Individuals were required to personally
sign reports that were issued to the public. This was implemented because in the tech bubble
collapse of 2000-2003 many financial statements of publicly traded corporations had been
misleading and incomplete, in many cases hiding debts as off book assets.28 Several high
profile companies like Enron and Worldcom had gone bankrupt due to these hidden debts and
this resulted in massive layoffs in the economy and losses for investors.

Not keen on the increased liability that Sarbane Oxley posed, large financial companies
looked for other options. Similar laws were not implemented in England and this attracted many
to move their operations to be based out of London, England. It also meant that debt
securitization grew quickly in the UK as it had done in the U.S and Australia. Household debt
levels climbed and home price appreciation took off well above historical averages.

When the mortgage debt bubble burst in the US in 2007, the British economy suffered a
downturn along with the rest of the world in the great recession. The rate of which loans were
being made slowed and home prices began to fall as shown in this next chart of UK homes prices
from 1991 to 2015.

28 "Corporate Services Blog." Corporate Services Blog RSS. N.p., n.d. Web. 13 May 2016.

Spencer Venable

In 2008, the largest investment banks were bailed out by governments and their
respective central banks, this helped financial markets stabilize. Although mortgage fraud was
acknowledged by the banking/investment industry no one was arrested or prosecuted. The
finance sector paid some fines and returned to making debt products. As a major finance capital,
the City of London recovered quickly. Home prices rebounded, households went back to
borrowing helping the british economy recover.

Feeling as though they were wealthy, many British people began borrowing money
against their homes and buying properties in other parts of the world, particularly in Europe as
countries like Spain. This caused a large boom in construction and related service jobs. However,
it was over investment and it created a similar scenario that China and Australia face with an
oversupply of housing and now cripplingly high levels of consumer debt.

Spencer Venable

The Bank of England recently reported that outstanding household debtincluding

mortgages and credit-card lendinghit a record 1.5 trillion ($2.2 trillion) in November 2015
and lending to households increased by 3.2% over a year earlier, the largest rise since late 2008.
On average, UK homes owed 26.5% of their annual income on loans and credit cards in the third
quarter of 2015, the highest rate since 2008.29

Now the U.K is faced with having to correct their economy and this is no easy task.
However the U.Ks government released a plan outline in 2015 outlining the steps they will be
taking to correct their economy. This plan involves focusing on the foundations of their economy
meaning the workforce and the nation's productivity. They wish to achieve this by implementing
things like: modern transportation, and world class digital infrastructure pushing their economy
towards a more tech based one. They also plan to cut corporation tax to 18 per cent in 2020,
which would save businesses 6.6 billion a year resulting in less money to the government but
more to the people.30

International Organizations
Federal Reserves

29"Household Debt Binge Hits Precrisis Level as Brits Go Mad for New Cars." This Is Money. N.p., n.d.
Web. 13 May 2016.

30 "Productivity Plan Launched." GOV.UK. N.p., n.d. Web. 19 May 2016.

Spencer Venable

The FED or US Federal Reserve was made in 191331, when the Federal Reserve Act was
put in place. The purpose of this act was to be a fail safe for the financial system if it were to
collapse. The Federal Reserve Act was made in response to the financial crisis that occurred in
1907. The passing of the act made the Federal Reserve System or FED. The FED serves as the
central bank of the United States. Another attribute of the act was allowing the creation of both
public and private financial institutions. The act required a board of governors to watch over the
FED, and it also is what started the creation of the Federal Reserve note which is the money used
today in America. The intent of the FED is to create economic stability, keeping the GDP roughly
the same. They do this by pumping money into the economy from the purchasing of stocks and
bonds. The stocks/bonds are for the most part purchased with money the FED printed. Due to the
FED being the creator of the world's benchmark currency they are the only NGO in the world
that is allowed to print it.

However, the FED is a NGO meaning a non-governmental organization. This being said the
board of governors for the FED are all chosen by the U.S president and approved by the head of
senet. The current seven governors that sit on the FEDs board are: Janet L. Yellen, Chair
(former Chair of the White House Council of Economic Advisers), Stanley Fischer, Vice
Chairman (former chief economist at World Bank), Daniel K. Tarullo (former employ in the
Antitrust Division of the U.S. Department of Justice) , Jerome H. Powell (prior partner of the
Carlyle Group) and Lael Brainard (Under Secretary of the Treasury for International Affairs).
The other two members of the board are whoever currently hold the position of the Secretary of
the Treasury and the Comptroller of the Currency. Jack Lew former COO of Citigroup currently
31 "Recent Developments." Board of Governors of the Federal Reserve System. N.p., n.d. Web. 13
May 2016.

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holds the position of Secretary of the Treasury and Thomas J. Curry prior Commissioner of
Banks for the Commonwealth of Massachusetts, is the Comptroller of the Currency32. The job of
these board members are to evaluate the different situations presented and decide the actions of
(in a completely unbiased manner) the FED.

In 2008 large amounts of spending from the FED was seen in response to the Great Recession.
Not only did the FED spend 1.7 trillion dollars on the reinflation of the American banking
systems but large spending on international banking systems was seen. It was confirmed that a
total of $16 trillion dollars was spent by the Fed to bail out banks internationally during and after
the Great Recession. Sen. Bernie Sanders is quoted as saying No agency of the United States
government should be allowed to bailout a foreign bank or corporation without direct approval of
Congress and the president.33. This statement is to say that Congress was unaware of the
spendings of the Fed, showing how distant from the government the organization has become.
The spending of FED helped banks Q.E (Quantitative Easing), an unconventional monetary
policy in which a central bank purchases government securities or other securities from the
market in order to lower interest rates and increase the money supply34) regain stability all
around the world; it allowed for them to continue to loan out money as they had been before the
near collapse. This is part of the reason why large amounts of inflation can be seen in countries
like Canada and Australia. The correction that would of taken place in 2008 when the markets
32 "Board Members." FRB:. N.p., n.d. Web. 13 May 2016.
33 Forbes. Forbes Magazine, n.d. Web. 23 Apr. 2016.
34 "Quantitative Easing Definition." Investopedia. N.p., 12 Apr. 2009. Web. 13 May 2016.

Spencer Venable

crashed was stopped, therefore allowing them to reach record highs that will collapse
catastrophically when they do.

CFPB (Consumer Financial Protection Bureau)

The CFPB was created as part of the Dodd-Frank Act in 2011. As the Dodd-Frank Act
was made for consumer protection the CFPB was labeled the consumers watchdog, regulating
the new rules and prosecuting those who dont adbi to them. The bureaus jurisdictions include:
banks, credit unions, securities firms, payday lenders, mortgage-servicing operations, foreclosure
relief services, and debt collectors. The CFPB has had many successful cases against law
breaking banks and other financial services. In 2015 the CFPB cracked down on Discover Bank
for overestimating the minimum amount due on borrowers' billing statements, misrepresenting
information that could have allowed borrowers to receive tax benefits and called borrowers early
in the morning and late at night, often excessively. The company also, according to the CFPB,
failed to provide defaulted borrowers with legally required notices about their rights. Discover
Bank lost the case and agreed to pay 18.5 million dollars to resolve the allegations put against
them.35
The organization is very effective in the prosecution of law breaking financial companies,
acting as a police force in the financial world
The International Monetary Fund (IMF)
International Monetary Fund was founded in 1945, it is an international organization of "189
countries working to foster global monetary cooperation, secure financial stability, facilitate
international trade, promote high employment and sustainable economic growth, and reduce

35 "Consumer Financial Protection Bureau." Investopedia. N.p., 28 Sept. 2010. Web. 13 May 2016.

Spencer Venable

poverty around the world..36 Countries put funds into a pool with promise of being able to
borrow money from the pool if they encounter balance of payments difficulties. The last public
update of the amount of money in the pool was in 2010 when they had SDR 476.8 billion. SDR
stands for Special Drawing Rights and almost acts as a common currency for all countries that
put funds into the IMF. For example 0.540 USD is worth 1 XDR and 34.0 JPY (Japanese Yen) is
worth 1 XDR. This system keeps the division of money between countries very simple.
However, XDR is not an official currency and cannot be used in any country. A flaw that the IMF
has however is the fact that members get votes based on the dollars they contribute to the fund.
This means that poorer countries that typically need money have less power to determine the
terms of how or when they are helped. Countries such as America who are able to put the most
money into the IMF are the largest shareholder resulting in them having more say over how
funds are handed out. They can require struggling countries to follow policies that favor the US
and US multinational corporations more than the local economy. This has drawn criticism that
the IMF can have more decision making power than citizens and voters in the countries
themselves. This policy of the IMF is called Structural Adjustment.37

Canadian Connection
Canada shares a similar story with Australia. During the lead up to the housing bubble in
America, Canadian GDP led by exports saw strong, steady growth as Canada is Americas main
supplier of natural resources. (Just as China is for Australia). As demand increased it pushed the
price of commodities, the value of Canadas exports and national income.
36 "About the IMF." IMF. N.p., n.d. Web. 01 May 2016.
37 "Structural Adjustment." Wikipedia. Wikimedia Foundation, n.d. Web. 19 May 2016.

Spencer Venable

The chart below shows the year over year percentage change in Canadian exports (in green) and
the price of the commodity index (in purple) from 1982 to 2015. Canadas economy expanded
strongly until 2008 when the U.S housing bubble crashed and the global demand for
commodities fell.

38

38 "Ted Carmichael Global Macro." : Canada's Recession Debate Misses the Point. N.p., n.d. Web.
13 May 2016.

Spencer Venable

This chart shows the growth of Canadas GDP 1965 to 2015.

Like Australias economy, Canada bounced back quickly from the 2008 recession
because of our concentration in resources. Stimulus spending from China and the US as well as

Spencer Venable

low interest rates helped to revive GDP and the willingness of Canadians to borrow and spend.
The Canadian housing market had been increasing strongly from 2003 to 2008. It dipped in the
2008 recession but rebounded quickly. In addition to Canadians borrowing record levels of
household debt to upgrade their homes, hot areas like Vancouver and Toronto saw large inflows
of foreign investors from places like China who were looking for assets to park money in outside
of the Chinese markets and banking system. This led to a rapid increase in home prices in major
cities and the national average. This attracted more investment into real estate construction in
Canada and led to strong job growth in that sector as shown in this chart of residential
investment and construction employment since 1976.

39

39 "The Most Important Canadian Charts to Watch in 2016." Macleansca. N.p., 09 Dec. 2015. Web.
13 May 2016.

Spencer Venable

Real estate prices increased as shown in this Canadian New Housing Price Index. At the same
time, the government lowered lending standards to allow more people to enter the property
market. A conventional mortgage historically required a 25% down payment but during the
1990s it was lowered to 10%. Then in 2006 the national standards were lowered to
downpayments of zero and payback periods (amortizations) were increased to 40 years, from the
usual 25. This allowed people who could not have purchased housing on traditional rules in the
past to suddenly be able to qualify for mortgages. In the process, household debt leaped as
shown in this chart comparing 2000 with levels in 2014.

Spencer Venable

Despite many people calling for a rebound in the price of oil, it has not recovered
significantly and is today still under $40 a barrel down more than 60% since 201440. At the same
time, the world has the highest oil supplies on hand in more than 80 years, while the global
economy continues to grow at less than 3% a year in 2016 (compared with more than 5% a year
during the credit bubble peak in 2007). This means that Canadas export values have not
recovered and are not likely to for some time. This is a problem because the country has the
highest total debt today (governments, businesses and households) that it has had in several
decades. With the jobless rate rising (thanks to many layoffs) many Canadians are having a
difficult time paying their debt payments while continuing to spend on discretionary items. This
is twice as hard for the economy because it means our exports are weak as well as our household
sector (which is responsible for 56% of Canadas GDP).

As a result less people are able to buy new homes and cars and other large ticket items
and related services. At some point over-indebted people then look to sell their houses and pay
down their debts. But with less people able to borrow more and buy, the prices of houses is
likely to move lower over the next few years. This risks pressure in the economy from loan
defaults, bankruptcy and losses in our banking sector. Because our banks are heavily exposed to
debt at all levels of our economy, it also increases the risk that the government will have to use
taxpayer dollars to bailout the banks.

40 "Economic Dashboard - Oil Prices." Oil Prices. N.p., n.d. Web. 13 May 2016.

Spencer Venable

Solutions
Efforts must be made to correct the removal of the Glass Steagall Act which was the
predecessor for the Great Recession, and a major cause of economie failures around the world.
The division between deposit taking banks and investment sales firms should be reinstated to
bring back the stability that was seen from the years 1933 to 1999.

Currently US Senator Elizabeth Warren and John McCain are attempting to bring back a
variation of the Glass Steagall Act called the 21st Century Glass Steagall Act. The bill is the old
Glass Steagall Act modified to fit modern times.

Our new 21st Century Glass Steagall Act once again separates traditional banks from
riskier financial services. And since banking has become much more complicated since
the first bill was written in 1933, weve updated the law to include new activities and
leave no room for regulatory interpretations that water down the rules. 41
-

Elizabeth Warren

41 "Support Elizabeth Warren's First Banking Bill." Elizabeth Warren for Senate. N.p., n.d. Web. 19
May 2016.

Spencer Venable

A specific - and largest adjustment in the new bill to provide for the complexity of modern
finance firms, is the instatement of a gradual transition period for investment companies splitting
into two distinct entities.

The bill will give a five-year transition period for financial institutions to split their
business practices into distinct entities shrinking their size, taking an important step
toward ending Too Big to Fail once and for all, and minimizing the risk of future
bailouts. 42
-

Elizabeth Warren

However, they are having a difficult time gaining support. Politicians that receive significant
funding from banks are reluctant to support the cause. Conflict of interest in this area are a hurdle
to effective regulation. People who are employed as influential politicians (especially those that
regulate banking and finance) must be required to limit their connections with and funding from
banks - both directly or through family members. Additionally there should be a period of at
least five years required before a politician or regulator can take a job with a large financial firm.
It is common for employment contracts in private businesses to have periods of non-competition
when a person leaves a company so that they cannot go directly to working for a competitor.
Similar cooling off periods should be required of people moving between government and
regulatory jobs to the businesses they are overseeing. This is likely to make regulators more

42 "Support Elizabeth Warren's First Banking Bill." Elizabeth Warren for Senate. N.p., n.d. Web. 19
May 2016.

Spencer Venable

focused on doing their job effectively, rather than thinking about how they can use their
experience to make more money in the private sector.43

Secondly the rules around loaning money must be tightened; high debt equals high risk. No
longer should people be able to take out mortgages with as little as 0% down. If people were
forced to have a minimum of 25% down--as it was for conventional mortgages--then much more
stability would be seen because it would stop people from taking out excessive loans on
properties and other investments. Market values would have a much harder time getting far
over valued and then crashing as people are much more careful with their capital when it's 25%
their money compared to 0%. It would also slow the amount of investments people are making
as it would take longer for them to save 25% of their purchase creating an overall more stable
environment.

Lastly lenders should not be able to package off the bulk of their loans and sell the risk of
collection to investors. They should be required to maintain at least 50% of the loans on their
books. That way lenders maintain risk and this will make them more careful in who they are
making loans to as well as in what amounts. This would also help to control the quality and
quantity of loans in our banking system. And this will help make it more stable and less likely to
need taxpayer bailouts.

An example of a country that has executed the proper steps to finding a solution is
Iceland. The history of Icelands financial system and its rapid growth is fascinating.
43 "Warren, McCain Introduce Bill to Bring Back Glass-Steagall." TheHill. N.p., 07 July 2015. Web.
13 May 2016.

Spencer Venable

In the year 2003 Iceland with only a few billion dollars and a population of 300,000 set
out to become a major finance center. Surprising to most, they came close to achieving this goal
during the years of global economic growth that are 2003 2007. During this time period the
U.S stock market managed to double its value while Iceland managed to multiply its stock
market values by a factor of nine. The few trillion dollars that the country started out with turned
into $140 trillion; making this small country on the tundra into a financial powerhouse.
Reykjavks (the capital of Iceland) real estate value tripled, as did the average Icelandic familys
wealth. All of this new money was tied to the investment banking industry and increasing levels
of debt. Nearly every school began offering courses on economics and money; Iceland was no
longer just a country it became like a hedge fund.

But as in other countries, lending standards deteriorated and loans were being given to
pretty much everyone who applied for one. When the 2008 global financial crisis and recession
hit Iceland, it hit them very hard. In total they experienced 100 billion dollars of banking losses,
which for a country the size of the state of Kentucky, was huge. It resulted in roughly $330,000
of debt owed for every person in Iceland, including children44. More savings was also lost due to
an 85% drop in the Icelandic stock market and foreign-currency speculations that many people
had been making. These are speculations made on the values of foreign currencies by a private
investor. In many cases, people in Iceland were borrowing funds in other currencies where
interest rates were lower. When the Iceland krona plunged in value, this made these loans much
larger and difficult to repay.
44 Person, and Vanity Fair Magazine. "Wall Street on the Tundra." Vanity Fair. N.p., n.d. Web. 13 May
2016.

Spencer Venable

Iceland went from zero to hero and back to zero in an astonishing 5 years. With debts
amounting to 850% of their G.D.P it appeared impossible. But it was what Iceland did in
response to its crisis, that truly set them apart from other countries.

A very distinguished professor from the University of Chicago named Robert Z. Aliber45
was invited to give a speech at the University of Iceland. Students, bankers and journalists sat in
to listen to the speech. During his speech he deconstructed the illusion the Icelandic people
seemed to have, in which they believed they had some sort of innate talent for high finance. He
described the Icelandic economy had all the signs to show a financial bubble of huge
proportions. After the speech when he was asked to predict the future, Aliber answered I give
you nine months. Your banks are dead. Your bankers are either stupid or greedy. And Ill bet they
are on planes trying to sell their assets right now. This caused much panic for the bankers in the
room and they tried with all their power to stop the speech from being published. However,
Alibers words spread quickly starting the push towards correcting Iceland's economy.

These words were also proven very true when the recession hit. The amount of money
that the 3 banks needed to get out of debt was not obtainable by the government resulting in the
collapse of the banks. Although the failure to re-fund the banks was not intentional, it was
something that worked very well for them in the long run. The badly managed banks and their
executives went bust and the government bailed out families who owed money instead. After
2009, Icelands economy (GDP) recovered quicker than in other countries as shown below. If

45 "Robert Z. Aliber." Wikipedia. Wikimedia Foundation, n.d. Web. 30 Apr. 2016.

Spencer Venable

America were to have done the same in 2009, they might have also experienced a stronger
recovery in the real economy.

The government also reacted wisely to the foreclosing of Icelands banks. New rules were
applied to the governing of banks to create more structured and transparent systems. The banks
were taken over by the government and recapitalized with cash increased to 16% of all assets.46
This insured a percentage of the money would be kept safely in the bank, and limited the amount
of loans that could be made with customer deposits. Although a disadvantage of this was Iceland
had to take on a tremendous amount of debt to pay for the funds they used to recapitalize the
system.

With the government taking on this debt themselves and eliminating all non-government
owned banks their debt is controlled. With no NGO banks giving out loans the country's national

46 "Cracks in the Crust." The Economist. The Economist Newspaper, 13 Dec. 2008. Web. 13 May 2016.

Spencer Venable

debt is controlled by the government. They prosecuted and imprisoned 29 people47 who were
convicted of overseeing fraudulent activities within the banks. This helped to serve as a
deterrence that such activities would no longer be tolerated and that individual actors could not
get away with breaking the laws and hiding within corporations. They also separated the
investment firms and the deposit taking banks, something that should have been done in America
after the recession. The act of separating them and paying back the debts of the public helped to
separate savings and chequing account deposits from the risk of stock markets, and this was a
good thing.48 Deposits that are needed to operate companies and households and savings that are
needed to fund things like education and retirement pensions need to be protected and built
carefully over time. When large portions of it are directed into asset bubbles (in things like
stocks and real estate) the inevitable collapse in prices has a devastating effect on the real
economy, businesses and families. If other countries were to follow the examples of Iceland,
markets and economic growth would be less boom and bust and more stable and stronger
overtime.

47 "Iceland: We Jail Our Bad Bankers and You Can Too." CNBC. N.p., 12 Feb. 2015. Web. 13 May 2016.
48 "Cracks in the Crust." The Economist. The Economist Newspaper, 13 Dec. 2008. Web. 13 May 2016.